Modeling Risk

Navigating and Managing Geopolitical Risks

Fueled by the ongoing Israel/Hamas and Russia/Ukraine conflicts, headline-grabbing geopolitical threats are a source of significant concern for financial institutions, which must consider their impact on energy prices, consumer and business confidence, market volatility, trade, and the supply chain. What steps can they take to measure and mitigate these unpredictable, idiosyncratic risks?

Friday, December 1, 2023

By Cristian deRitis


Geopolitical risks are broad, complex and hard to predict. Just consider, for example, the ramifications of the ongoing Russia/Ukraine military conflict in Ukraine, which has increased tensions between Russia and the West; the ongoing hostilities between Israel and Hamas, which has sparked violence and humanitarian crises in Gaza and the West Bank; and the escalating tensions between China and Taiwan, which have provoked military threats and sanctions.

Given the difficulty in accurately assessing both the likelihood and severity of an extreme tail event, how can risk managers deal with these challenges effectively? Let’s now take a closer look at geopolitical risks and consider the best approach for managing and mitigating these threats.

What are Geopolitical Risks and Why are They Important?

Geopolitical risks are events (e.g., regional wars) or situations (e.g., cyberattacks) that involve political, economic or social conflicts between countries or regions. They can affect the stability and security of the globe, as well as the interests and operations of individual businesses, other organizations, and households.

 Cristian deRitisCristian deRitis

We have already cited some of the most visible and urgent geopolitical risks, but they are far from the only ones. Many other regional conflicts and issues have the potential to escalate or trigger other risks, such as cyberattacks, terrorism or environmental disasters. Even if the likelihood of any individual threat is small, risk managers need to be aware of the global landscape and the potential flashpoints that can affect their businesses or organizations either directly or indirectly.

A Process-Based Risk Management Approach

Geopolitical risks are some of the most difficult risks to manage and mitigate, because of their highly idiosyncratic and uncertain nature. Their timing and severity are unpredictable, and they often lack transparency because of insufficient data.

Traditional risk management methods, such as historical analysis, may therefore fail to capture the complexity and exponential nature of these risks. Instead, risk managers should adopt a process-based approach. The first step is to identify the impact channels through which geopolitical risks may affect both the economy and specific industries and subsectors.

Impact channels related to geopolitical threats include:

  • Energy prices: Geopolitical instability can disrupt energy production and transportation, leading to price volatility and supply-chain disruptions.
  • Consumer and business confidence: Heightened geopolitical tensions can erode consumer and business confidence, dampening economic activity and investment.
  • Financial market volatility: Geopolitical shocks can trigger panic selling and capital flight, leading to significant market volatility and potential financial crises.
  • Trade and supply-chain disruptions: Geopolitical conflicts can disrupt cross-border trade and supply chains, causing shortages and price increases for essential goods.

For each impact channel, risk managers should assess the likelihood and magnitude of the risk, recognizing that these estimates are largely subjective and prone to revision.

From Impact Channels to Scenarios

After identifying the ways a geopolitical risk might influence the factors impacting operational, credit, market or other risks, firms can then design econometric scenarios incorporating various assumptions surrounding each of these impact channels. For example, a company may want to explore the impact on their portfolio from a sharp increase in the price of oil to, say, $125 or $150 a barrel for an extended period.

Once scenarios are defined, standard processes around stress testing and crisis planning can be applied to translate these shocks into firm-specific effects. However, for this analysis to be meaningful, on top of estimating the direct financial impact on revenues or credit portfolios, risk teams must take additional steps.

First, they need to develop contingency plans and mitigation strategies. For each impact channel, they’ll need to identify the actions and measures that they can take to reduce their exposure or to respond to a crisis if it occurs. For example, companies might look to diversify their energy sources, hedge currency exposures, strengthen cybersecurity, and/or relocate supply chains.

Second, risk teams will want to monitor and update their risk assessments and plans regularly. Geopolitical risks are dynamic and evolving, so they will need to keep track of the changes and developments in the global environment. To stay informed and alert, teams can use various sources of information – such as news reports, country risk scores and experts.

Preparing for the Unforeseeable

A process-based approach can help manage and mitigate the known and foreseeable geopolitical risks, but it may not be enough to prepare for the unknown and unforeseeable ones. These are the risks that are so rare or unexpected that they are hard to anticipate or plan for, such as a large-scale cyberattack on the financial system, a regional war, or a global pandemic. How can we deal with these risks?

One way is to adopt a resilient mindset and culture, which means being flexible, adaptable and innovative in the face of uncertainty and change. Rather than attempting to anticipate every possible contingency, we can build resilient organizations that have the capabilities and resources to cope with and recover from shocks and disruptions.

Resilient organizations have three key characteristics:

  1. They prioritize the safety and well-being of their staff and customers. The COVID-19 pandemic showed the importance of having remote work options and cloud-based infrastructure to protect staff, preserving their ability to continue to support their customers.
  2. They have a diversity and redundancy of systems and networks. This helps avoid single points of failure and increases resilience to disruptions and attacks that could come from any direction. For example, firms should have multiple suppliers and backup systems, as well as alternative shipping routes that allow them to pivot as needed.
  3. They foster a culture of continuous learning and improvement of processes and practices. This helps organizations learn from mistakes and successes, improving both performance and efficiency. For example, resilient organizations conduct regular reviews, audits or simulations to test and enhance their risk management and crisis response capabilities.

Learning From History

The world today may seem more dangerous and riskier than ever. But it’s important to bear in mind that the number of people who are now directly engaged in warfare remains low by historical standards. Societies, moreover, have faced and overcome many existential crises and calamities in the past.

In fact, many of the risk management practices and institutions that we have today are the result of learning from and responding to previous disasters. The banking crises of the 19th and 20th centuries, for instance, led to the creation of central banks, deposit insurance and financial regulation to prevent and manage future crises. The World Wars of the 20th century, meanwhile, led to the formation of the United Nations, NATO and other intergovernmental organizations to promote peace and cooperation among nations.

These examples show that risk management is a method to cope with and survive an existing crisis, learn from previous disasters and prevent future fiascoes. For risk managers, this multi-pronged process entails not just managing and mitigating the risks they currently face but also advocating for and supporting the solutions that can resolve current crises and prevent future ones.

Risk Managers as Advocates

One of the most important and effective ways to prevent or resolve geopolitical risks is through nonviolent dispute resolution involving diplomacy, dialogue, mediation or other peaceful means to settle conflicts. Nonviolent dispute resolution can help avoid the escalation and violence that can result from geopolitical risks, fostering mutual understanding and cooperation among parties.

Risk managers can be advocates for nonviolent dispute resolution by quantifying and communicating both the potentially devastating consequences of armed conflicts and the benefits created by peaceful solutions. By presenting a clear and convincing picture of the risks and lost opportunities to both sides of a conflict, risk managers can influence and persuade the decision-makers and stakeholders to choose the nonviolent option.

Parting Thoughts

Geopolitical risks are complex and challenging, but they are not insurmountable. Risk managers can navigate and manage these risks effectively, and contribute to a more stable and secure world, by adopting a process-based risk management approach that (1) identifies impact channels to develop econometric scenarios; (2) prepares for the unforeseeable; and (3) advocates for nonviolent dispute resolution.

Furthermore, we also need to bear in mind that for all of the talk about deglobalization and de-risking, countries, businesses and even individual households remain highly interdependent on each other through energy, commodity and financial markets. Preparing for the worst while simultaneously working to diffuse conflicts is at the heart of geopolitical risk management.

Cristian deRitis is the Deputy Chief Economist at Moody's Analytics. As the head of model research and development, he specializes in the analysis of current and future economic conditions, consumer credit markets and housing. Before joining Moody's Analytics, he worked for Fannie Mae. In addition to his published research, Cristian is named on two U.S. patents for credit modeling techniques. Cristian is also a co-host on the popular Inside Economics Podcast. He can be reached at


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